company profit sharing plan

Employer Case Study- “Company Profit Sharing – How Much do I GET?”

(The short as I could make it version)

Everybody likes a tax deduction. The question is how much of the profit sharing goes to YOU, the business owner?

Of course, the facts make a difference, and individual results will vary. So, let’s go through the scenario. The electrician business owner is over 59 1/2 years old, and the company has plenty of taxable income, with a couple of younger employees, two of whom are family members. I put the company tax return on extension, which allowed us some time to review different strategies until the filing due date of October 15. Of course, most strategies must be done during the year but in this case, a profit-sharing contribution can be made up until the time the tax return is filed. The electrician business owner and I decided on setting up a new profit sharing and 401K plan for the company. He was very concerned about being able to take the money out if he needed it. Since he was over the age of 59 ½ he could do it without the 10% penalty but of course, the distribution, only the amount taken out, would be subject to tax in the year received. If you’re under 59 ½ and overly concerned about having the money available, then a profit-sharing retirement plan contribution is probably not a good idea.

The part where most of the profit-sharing went to the business owner is based on the method used for the profit-sharing contribution. The quick explanation is that older business owners with higher wages and income will get most of the contribution. In contrast, the younger and lower-paid employees will receive less of the profit-sharing contributions. In this case, two employees were family members, so over 90% of the contribution went to him and his family. Pretty good deal if you ask me. Note: if the employees are all over the age of 50 and have high wages then the profit-sharing contribution will be more evenly spread to everyone. A retirement plan administrator has specialized software to calculate how much each employee will be allocated. There is usually a fee for this calculation. An additional benefit is that if the outside employees leave before the vesting is complete, some of their contributions will revert back to the company.

So, in this case, roughly $66,000 was deducted on the company tax return, and over $58,000 went to him and his family. Plan setup costs were less than $3,000, and our friendly IRS helped cover some of that to the tune of $500. See my blog post “First Time – New Retirement Plan Tax Credit.” Thus, a tax savings of about 35% or $23,000. The profit-sharing contribution was $63,000; the plan cost $3,000, and the IRS tax credit savings is $500. The total out-of-pocket costs were $7,500, half of which went to employees and family members. The savings of $23,000 less $7,500 = $15,500 net cash tax saved. I consider the $3,000 of employee contributions more of an investment in his company versus a cost, as employee turnover can be expensive.

Most smaller employers do not realize that this type of retirement plan strategy is available. Depending on your employees’ age and wage level; it can make up for all the years they spent building up the company with tight cash flows and no “extra” money left for retirement savings. Thus, the IRS/government realizes this scenario and provides a way for those smaller employers, who have kept our economy going, to make up for their lean years within the legal minimum tax regulations.

As always, seek the advice of your financial professionals before implementing any method on your own.

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Ken Gibbons, CPA & CPFA